Conflicts of Interest: Steering Clear of Potholes and Other Bumps in the Road

Most family foundations prefer to focus on the business of giving, without having to worry about tripping over the sometimes obscure rules and regulations that govern this work. But the fact is that family foundation boards need to be aware of potential potholes on the road named philanthropy. Driving blind down this road can get you into trouble.

One potential pothole is real or perceived conflict of interest, a topic frequently misunderstood, and often confused with self-dealing.

Briefly, a conflict of interest can arise when a foundation board member or officer has a personal interest in a transaction that may be inconsistent with the best interests of the foundation. Another way to think of this is that under fiduciary standards, the duty of loyalty requires that board members set aside personal interests and act solely in the best interests of the foundation.

Events that may constitute a conflict of interest, or the appearance of a conflict, include occasions when a foundation board wants to:

  • make a grant to an organization that has a foundation board member also serving on its board
  • lease extra space in a building it owns to a grantee for below-market rent when a foundation board member is on the charity’s board
  • hire a board member’s law firm to provide legal services at the firm’s normal rates, which are consistent with rates charged by other law firms in town
  • hire the president’s spouse as a program officer
  • make grants to a charity run by a board member’s child

There are a number of reasons why it is important that boards handle conflicts of interest appropriately. Some – but not all – conflicts of interest can lead to the violation of self-dealing rules for a foundation, and create legal liability. Other conflicts, while not technically outside the law, carry the very real risk of negative public perception or reaction.

In its lengthy article, “Avoiding the Bad and Managing the Good,” the Council on Michigan Foundations suggests that family foundations imagine the following headlines:

  • Foundation pays millions in executive retirement
  • Local foundation grant funds job for foundation trustees
  • Foundation trustees steer contracts to family members

Even if there is no conflict of interest, the above headlines demonstrate the importance of public perception when it comes to foundation operations. As our grandmothers used to tell us, “Don’t do anything you wouldn’t want to see in the newspaper.” To that, we can now add, “…that you don’t want to see on the internet in five minutes or less.”

Conflicts of interest can also compromise the foundation’s decision making processes if board members have non-disclosed affiliations with nonprofits, or significant interest in a business that has direct or indirect dealings with the foundation. The personal or financial interests of the foundation board member may be negligible, but questions can be raised about the potential undue influence of close relationships of this kind.

In recent years, the IRS has increased its focus on conflicts of interest and how charities (both private foundations and public charities) are handling those conflicts. IRS Form 1023 now asks from the outset whether or not the organization has a conflict of interest policy. In addition, IRS agents use a governance check sheet whenever they choose to audit a charity. This check sheet includes a question about whether or not an organization has a conflict of interest policy, as well as a companion question asking if the policy is being followed. According to Kelly Shipp Simone, Deputy General Counsel with the Council on Foundations, the IRS clearly believes there is a connection between good governance practices and tax law compliance.

State regulators are also interested in whether or not a foundation has a conflict of interest policy. This is particularly the case in states like California and New York, where there has been traditionally more active oversight of foundations and nonprofits. If something goes wrong with a public charity or private foundation, the State of California will look closely at issues of conflict of interest and will ask if there was a policy in place and if that policy was followed.

Foundations also need to be mindful of public perception and the press. An appearance problem can lead to unwelcome publicity. A story is a lot less intriguing when an organization can clearly explain how its board arrived at a grant-making decision and how a conflict of interest policy was followed.

Lastly, the philanthropic community and the nonprofit community at large have seen the development of more guidelines and standards for good practice. The Council on Foundations’ Stewardship Principles for Family Foundations recommend that conflict of interest policies be written and put in place.

Conflict of Interest Policies: One Size Does Not Fit All

While legal experts and nonprofit leaders strongly recommend that family foundations follow written Conflict of Interest policies, presenters on a recent National Center conference call on this topic stressed that one size does not fit all.

“Flexibility is important,” says Kelley Shipp Simon of the Council of Foundations. “How you handle a conflict of interest depends on the type of conflict and the nature and make up of your foundation.”

There is no one template that will work for all family foundations, which can be highly individualized in their operations and dynamics. For example, a policy developed for a staffed family foundation will be different than a policy developed for a foundation run by family members, or a foundation that has both family and community members on the board.

Many foundations do not allow staff or board members to serve on the boards of community nonprofits because of fears of real or perceived conflicts. Others, like the Z. Smith Reynolds Foundation in Winston-Salem, North Carolina, take the opposite view. “We believe strongly in the importance of board and staff members being active in the nonprofit sector,” says Mary Mountcastle, President and Board Member of the Reynolds Foundation. “I have seen over and over again the value that people bring when they have that on-the-ground knowledge.” Mountcastle adds, “It’s important to experience the other side of the power dynamic. If you’re working as a volunteer or staff member at a nonprofit and you have to seek grants yourself, you quickly find out what it’s like to be on the other side of the fence.”

Diana Gurieva, Executive Vice President & CEO of the Dyson Foundation in Millbrook, NY, adds, “The important distinction is that people need to understand what role they are in when grants are being discussed. I don’t believe that making grants because they are of interest to a particular family member represents an automatic conflict of interest – we work very hard to apply the same due diligence and the same review to those grants as we do to the other grants that fall into our local funding guidelines.”

In addition to having a written Conflict of Interest policy, the Dyson Foundation requires that all board and staff members fill out an annual disclosure. “Even though we had the written policy, our experience was that people tended to forget [about potential conflicts],” says Gurieva. ”When you have a written policy and people have to re-sign it every year, they are reminded that there are a variety of potential conflicts that involve organizations they’re affiliated with. It’s a helpful nudge.”

Developing the Policy: Tips and Techniques

The first step in developing a Conflict of Interest policy is to acknowledge that conflicts very likely exist and they are not inherently bad. Having an open board discussion helps to normalize the idea that a variety of different conflicts of interest will typically arise in family foundations.

Once that discussion has taken place, there are several key elements to developing a Conflict of Interest policy (these can also be helpful for those organizations reviewing existing policies):

  • Define who is subject to the policy. Some policies cover board, staff and volunteers. Other staffed family foundations choose to have separate policies for staff and board.
  • Decide how your foundation will define conflicts of interest. Will the policy be a broad one that applies to any instance when people have conflicting loyalties? Will it focus only on potential financial conflicts?
  • Make sure the Conflict of Interest policy has procedures for dealing with conflicts. For example, after a board member discloses a conflict of interest, will h/she be asked to leave the board room prior to a vote? Will h/she stay in the room for the discussion leading up to the vote?
  • Ensure that the policy contains clear instructions on how conflicts of interest will be documented in board meeting minutes. For example, if a board member announces a conflict of interest, excuses herself from a discussion, and subsequently leaves the room, that should be noted in the meeting minutes.
  • Finally, decide whether or not to ask board (and staff) members to fill out one page annual disclosures. Asking board and staff members to annually disclose any connections they, their spouses, or their family members might have with potential grantees or businesses reminds people that there is a policy, and forces them to be continually aware of the conflicts they may have.

Family foundations should not be concerned that a conflict of interest automatically precludes making a grant to an organization that is of particular interest to a family member. Provided there is a written policy and the foundation board has exercised the same due diligence and review that is applied to all grant applicants, it is still possible to make a grant directed by a family member.

There are many examples of Conflict of Interest policies available on line. Those wishing to conduct further research may want to visit the resources listed in the box below/at right.

Ultimately, developing a written Conflicts of Interest policy is about creating an open culture for discussion in the foundation board room. Having a written policy provides the board with a roadmap that can be followed if and when conflicts arise. It also helps establish a culture of normalcy around the issue of conflicts. Conflicts are inevitable. They are the sign of an engaged board, which ultimately leads to good philanthropy. ..which is why you started down this road to begin with.